Central Bank Of Kenya To Remain Neutral Over 2020

At Fitch Solutions, we forecast average inflation of 5.9% over 2020, up from 5.2% in 2019 due to rising food prices.

Following the repeal of a cap on commercial bank lending rates and a policy rate cut of 50 basis points (bps) in November 2019, we expect the Central Bank of Kenya to hold its policy interest rate at 8.50% over 2020.

Though outside our core view, we believe there is a greater likelihood of monetary tightening rather than easing over the short term amid upside risks to inflation.

We expect Kenya’s inflation rate to average 5.9% over 2020, up from 5.2% over 2019. Headline inflation stood at 5.8% y-o-y in December 2019, up from 5.6% the previous month. This latest uptick was driven by food and non-alcoholic beverages inflation of 10.0% in December - the highest since September 2017 - following delayed rainfall impeding crop output and weighing on food supplies. Meanwhile, price growth for housing and energy utilities remained relatively low and 2.4% in December. We expect constrained agricultural production to drive food prices upwards over 2020. However, our core view is for an environment of subdued global oil prices (see ‘Brent: Improved Sentiment To Outweigh Weaker Fundamentals’, January 7) to help contain domestic energy and transport price growth over the short term, contributing to overall inflation remaining within the Central Bank of Kenya (CBK)’s target range of 2.5-7.5%.

Rising Food Prices Will Push Inflation Upwards

Kenya - Inflation And Components, % y-o-y

Source: Kenya National Bureau of Statistics, Fitch Solutions

Following a cut of 50 basis points (bps) in November 2019, we expect the CBK to hold its policy interest rate at 8.50% over 2020. The central bank’s November statement cited expectations for inflation to remain within the target band over the near term, as well as parliament’s repeal of a cap on commercial banks’ lending rates in November, as providing room for lowering the policy rate (see ‘Sub-Saharan Africa Reform Tracker: Some Progress, But Political Constraints Remain’, November 6). The rate cap, which prohibited bank lending rates from being more than 400 basis points above the policy rate, was implemented in September 2016 with the aim of improving access to credit and bolstering economic activity. However, the result was banks opting to reduce lending to higher-risk borrowers. This constrained credit growth and was criticised by policymakers for keeping economic growth below potential while reducing the effectiveness of monetary stimulus.

The removal of the cap is intended to allow banks to increasingly lend at rates they deem suitable for a wider range of borrowers. Although inflation is set to accelerate moderately, our core expectation is for this increase to not be strong enough to force the CBK to hike in 2020. We forecast the removal of the rate cap, the CBK’s cut and still relatively contained inflation to provide tailwinds to private consumption over the coming quarters, contributing to an acceleration of real GDP growth from 5.4% in 2019 to 5.7% in 2020.

Despite signs of moderating economic activity – with real GDP growth slowing to 5.1% y-o-y in Q319 compared to 6.4% in Q318 - we believe the gains from further lowering interest rates will be limited over the coming quarters, preventing the CBK from implementing more stimulus. Firstly, the banking sector's ratio of non-performing loans stood at 12.3% in October 2019, up from 8.7% in September 2016 when the cap was put in place, reflecting a riskier lending environment. In turn, we expect banks will still be comparatively cautious in providing credit to households and firms, limiting the gains from more aggressive central bank stimulus. Moreover, with rising domestic food prices and inflation weighing on real interest rates, we expect the CBK to avoid further rate cuts that could risk exacerbating depreciatory pressures on the shilling and raising imported price pressures.

Though outside our core view, we believe there is a greater likelihood of monetary tightening rather than easing over the short term. There is scope for inflation over the short term to exceed our projections, which could motivate a rate hike. Food insecurity could worsen and raise inflation further due to a renewed deterioration of weather conditions or damage to crops caused by locusts, with the latter having already caused substantial damage in neighbouring Somalia and Ethiopia. Additionally, a renewed increase in global risk-off sentiment could increase downward pressure on the Kenyan shilling in foreign exchange markets, raising import prices and pressuring the CBK to hike at the risk of weighing on credit and GDP growth.